Your Own Manufacturing Operation vs. Contract Manufacturing

//Your Own Manufacturing Operation vs. Contract Manufacturing

Your Own Manufacturing Operation vs. Contract Manufacturing

Before addressing this question, with the current trade war and “sourcing out of China” situation, WHY should anyone even consider moving manufacturing to China or even opening a plant there?

What do companies that did move production to China now have to say about that decision?  In March 21, 2018 manufacturing companies with operations in China were asked “have any of you actually moved your operations out of China to the countries you have identified or to any other countries in the world? … In spite of the consistency of their complaints, NONE of the participants had moved their manufacturing operations out of China. Most had tried some other country, with Viet Nam, The Philippines, Malaysia, India and Bangladesh being the most common countries explored. But every person in the group had abandoned these plans and had either kept their operations in China or moved their operations back to China.” (https://www.chinalawblog.com )  So clearly many companies continue to find it profitable to manufacture in China.

Regarding the current tariff game of “ping pong” between the U.S. and China it is difficult to determine the final outcome. The best solution which has been suggested in open discussions by the Trump Administration would be to eliminate all tariffs. How is your decision impacted by the potential tariffs? If your market includes other countries or within China itself, these tariffs will not impact your sales and the China price advantage may still be justified.  It should also be pointed out that if China is your largest market the reverse will be true if you are currently manufacturing in the U.S.  as the higher U.S. manufacturing costs will be increased by the Chinese tariffs on your products making it more difficult to be competitive in China, thus creating an additional cost savings by moving to China. To assess the benefits of establishing your manufacturing operations in China the potential tariff impacts should be incorporated in your assessment of the other pros and cons of manufacturing in China. (For a thorough evaluation See Chapter 1, Why the Middle Kingdom, in  “13 Steps to Manufacturing in China, The Definitive Guide to Opening a Plant, From Site Location to Plant Start-Up.”)

The new tax law has provided additional benefits for manufacturing overseas. “Before 2018, the U.S. government taxed companies’ foreign earnings in a highly unusual way. It applied the 35 percent U.S. corporate rate to their global income (minus foreign taxes paid), but collected the tax only when they brought the money home. So, companies left it abroad, building a stockpile of as much as $3.1 trillion.

The Tax Cuts and Jobs Act of 2017 changed all that, bringing the U.S. more in line with other countries. For one, it lowered the corporate tax rate to a more competitive 21 percent. It also largely eliminated taxation of foreign earnings, and imposed a one-time tax — 15.5 percent on cash, 8 percent on other assets — on what companies had already accumulated.” (Mark Whitehouse, Bloomberg, June 8, 2018)

Once you have evaluated the pros and cons your next step is to identify the steps required to create your own Chinese manufacturing operations.  You can then compare that with utilizing a contract manufacturer.  Another “compromise” approach would be for you to enter into a joint venture with an existing Chinese company that manufactures similar product lines.  Without going into the details in this article I would recommend that you avoid that option.  It will and has worked for some companies but that can be the subject of another discussion.

Having maneuvered my way through the challenges of establishing a manufacturing operation in China I will provide a brief overview, aka a “Readers’ Digest”, version of what we dealt with.  I have used the metaphor of “climbing the great wall of China” to describe the various steps.  The great wall has steps that are only a few inches in height difference as well as steps that are over a foot higher.  So, some of the steps are more difficult than others as you work your way to the top.  In this process you should remember the Chinese saying “He who asks a question is a fool for five minutes; he who does not ask a question remains a fool forever”.

Following are the recommended steps. (Excerpted from Chapter 2, “13 Steps to Manufacturing in China, The Definitive Guide to Opening A Plant, From Site Location to Plant Start-up”):

  1. As in any project of this size you need to establish project teams. – I recommend that you create an Executive Team and an Implementation Team. It is critical that you include your top management in the Executive Team so that they are involved with the 50,000-foot decisions.  It is also important that you identify and hire an ex-pat to be your on-site general manager at the beginning of the process.  He will provide the necessary translation requirements as well as assist you in recognizing discussions that relate to Chinese customs that you may not be aware of.
  2. Identify Potential Locations – This may require more investigation than you might have used if you were considering a location in the U.S. Some factors to consider include the need to be located close to a port for easy access to shipping in and out of the country. Many companies choose to establish operations in Industrial Parks as they more likely have the necessary infrastructure required.  But beware, for example, some locations may not have ready access to natural gas so you will need to utilize propane tanks.  If you are looking for the lowest possible wages then you may consider establishing your operations more inland in the lesser developed locations.
  3. Identify Industrial Park Incentives – Some locations may offer you reduced taxes for a period of time as you establish your operations. Some may only allow certain high-tech operations in their parks – but beware of potential intellectual property challenges.  Negotiate with the Industrial Park officials for your best deal.
  4. Meet with other Companies – There is a Chinese saying “Only he that has traveled the road knows where the holes are deep.” You can’t put a dollar figure on the benefits of meeting with local companies that are manufacturing in the locations you are assessing. Those discussion can help you identify the issues they dealt with and how they overcame them.  If they were able to negotiate a good arrangement with the local government you may be able to use that as a template for your deal.
  5. Learn the Environmental Regulations – Just as in the U.S. there are many documents that have to be created to obtain a permit if your operations include wastewater and/or air emissions or hazardous waste removal. Unlike the U.S. there are no independent companies to “split samples” with when the local environmental agents come to your facility to test your emissions.
  6. Select Desired Location and Negotiate the Memorandum of Understanding – The Memorandum of Understanding or MOU is a non-binding written agreement (in both English and Chinese) between your company and the local government. There are many specifics that should be included in this document – the aim of the establishment of the proposed foreign-capital enterprise, the scope and scale of the business operations, the technology and equipment to be adopted and used, the amount of land to be used and related requirements, the utility requirements and projected usages of water, electricity, natural gas and any other forms of energy required and any requirements for public facilities, etc.
  7. Establish Your Company – Before you can start any work in China, including spending money for your operations, you must establish your company. There are several documents that must be prepared.  All of these documents must be completed and the process can take several months.
  8. Import Used Manufacturing Equipment – You can import most used equipment into China from the U.S. The advantage of using your own equipment is that you know that it has been able to manufacture your product to your specifications in the U.S. so you should be able to duplicate the quantity and quality in China.  You should also consider establishing an initial pilot operation to demonstrate that you can manufacture your product meeting the target quality and production rates with both imported and possibly China sourced equipment.  Be aware that there are procedures to follow which include inspections and inspection related costs conducted by Chinese personnel located in the U.S.  These personnel can help you determine if any of your equipment cannot be imported to China.
  9. Source Chinese Equipment – There can be potential significant savings purchasing Chinese manufactured equipment. You may find that the Chinese can duplicate higher cost equipment that you would otherwise have to purchase and import into China.
  10. Select a Design Institute – You will need to identify and hire a design institute to design your plant. Even if you do your own design you cannot implement any construction without a review and sign off by the Chinese DI.  You will not likely find many DI’s that speak English so this is where your ex-pat GM is critical.  You will also find that design drawings, particularly electrical, do not follow the same western electrical criteria so it will be important to have this reviewed in detail by your electrical engineer on the implementation team.  The DI’s are also rated regarding what they can design and their respective quality (A being the highest).
  11. Evaluate and Select a Construction Company – Like the design institutes construction companies are also rated according to their expertise and quality. If you are working with a government developer which is likely what you will need to do, they will arrange a meeting with several different construction companies with whom you will review the scope and select one.
  12. Construct the Manufacturing Plant – You might think this could be easy part as you have selected your construction company but before you can remove the first shovel full of dirt you will need a building permit. This includes an approval from a plethora of city organizations including the District Planning Commission, the City Environmental Bureau, the District Land Planning Bureau and eleven yes 11!) more local approvals.  Some Industrial Parks may assist you in this process.  You should consider having your own staff on hand to follow construction as well.
  13. Hire Plant Staff – With a new company established and your construction and equipment installation complete you will need to locate and hire the Plant Staff. Some of the staff should be in place prior to this step like the General Manager and Plant Engineer.  You will need an account to handle the dual books (English and Chinese).  A purchasing manager must be hired in time to buy the Chinese sourced equipment   This person should be above approach to avoid “under the table” or “red envelope” payments.  After equipment is installed the plant engineer will hire the maintenance staff at the same time an operator is hired to learn how to operate the equipment.  The best approach is to have them both come to your plant in the U.S. to learn how to manufacture your product.  If you will be importing any equipment or raw materials into China you will need a member of staff, possibly the purchasing manager, to coordinate with the industrial park customs officials.

Nothing to it right?  Well the steps noted above only just begin to scratch the surface of this process.  This may make you immediately decide this is not for me and decide to have your product produced by a contract company.   Contract manufacturing works best when your product does not require extremely sophisticated equipment and process control, or is not highly capital intensive and the process must remain confidential and out of the hands of your competition as “there are no secrets in China”.

For all of the details (and I mean every detail) that you need to know before deciding if you want to establish your own manufacturing in China you should first read “13 Steps to Manufacturing in China, The Definitive Guide to Opening a Plant, from Site Selection to Plant Start-up” by  Bruce W. Mitchell.

2018-11-27T21:01:20+00:00October 27th, 2018|Uncategorized|0 Comments

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